Yesterday, the Chancery Court of Tennessee issued an order order setting a trial date for Dec. 10 in the material adverse change dispute between Finish Line and Genesco. In doing so, the Chancery Court rejected the arguments of UBS [the intervenor] to set the trial for Jan. 7. The Chancery Court stated:

In setting the MAE trial for December 10, 2007, and rejecting the Intervenor's request for a January 7, 2008 trial date, the Court has concluded that the provision of the Merger Agreement that allows Genesco to cure an MAE before December 31, 2007 is not a ripe issue, and, therefore, does not warrant delaying the trial to January 7, 2008. The Court's conclusion is that under the terms of the Merger Agreement, as applied to the circumstances of this case, Genesco's right to assert that it has cured a defect in its performance is not an issue until a defect in performance has been demonstrated.

The Chancery Court's conclusion here appears right. Likely UBS was arguing that the Court should only decide the issue once it was impossible for Genesco to cure the MAC under the merger agreement which has a drop dead date of Dec 31, 2007. Here, the judge I think correctly says that issue is not ripe--if there is no MAC now there is nothing to cure.

Also, it appears that UBS has dropped its objections to being brought into the suit. It was granted intervenor status in the dispute by the Judge pursuant to the order. UBS likely asked for intervenor status in order to preserve its option under its commitment letter with Finish Line to require any litigation between the two to be in a New York court.

Finally, the Judge accepted Genesco's offer to respond to Finish Line's and UBS's information requests and set an Oct 31 hearing to discuss any further information disputes. The Judge in part stated:

Construing and applying the terms of the Merger Agreement, the Court concludes that a 77% drop in second quarter earnings from the previous year is sufficient on its face to trigger Genesco's obligation to respond to the request of the defendants to provide information about the second quarter loss in earnings in connection with the MAE provisions ofthe Merger Agreement.

I wouldn't make to much of the judge's statement about the 77%. If there is such a decline and it is sustained it would likely be MAC to the extent Finish Line was not aware of it at the time of the agreement or it otherwise wasn't excluded from the agreement. All of these are big outs. So, the Judge still has a long ways to go before finding a MAC. In this regard, retail is a highly cyclical business as a whole and the MAC clause in the merger agreement excludes out:

(B) changes in the national or world economy or financial markets as a whole or changes in general economic conditions that affect the industries in which the Company and the Company Subsidiaries conduct their business, so long as such changes or conditions do not adversely affect the Company and the Company Subsidiaries, taken as a whole, in a materially disproportionate manner relative to other similarly situated participants in the industries or markets in which they operate;

as well as:

(D) the failure, in and of itself, of the Company to meet any published or internally prepared estimates of revenues, earnings or other financial projections, performance measures or operating statistics; provided, however, that the facts and circumstances underlying any such failure may, except as may be provided in subsection (A), (B), (C), (E), (F) and (G) of this definition, be considered in determining whether a Company Material Adverse Effect has occurred

This dispute will now revolve in large part on what Finish Line finds during its information hunt. Even if Finish Line discovers any new information, Genesco will attempt to show that Finish Line already knew of these facts as the deal was reached a good month into the quarter Finish Line is now complaining produced a MAC. Genesco will also argue that any MAC is excluded under the exceptions above. Here, it will rely for publicity on (D) to claim no MAC has occurred. Something to the effect of "how dare you say there was a MAC when we explicitly excluded out failure to meet projections". But this exclusion does not except out the underlying changes which actually did produce the MAC. So, ultimately, to the extent Finish Line can even establish that something materially adverse occurred, Genesco will fall back on (B). In this regard, Finish Line's results were none to great this last quarter either. Bottom Line: There is still a long journey for Finish Line and UBS before they can find the facts to establish a MAC, though I will say the Judge appears open to their arguments. And they will now have the opportunity to find such facts. Ultimately, I think the argument will center on whether any adverse event is excluded by (B).

Though the incentives of the party are still strongly biased towards a settlement shortly before trial, I continue to hope for at least one MAC decision out of all of these cases. If it is a Tennessee one and not Delaware, so be it. For more on the legal arguments see my prior post here.

NB. The Judge's order also likely cures Finish Line's other claim that Genesco breached the merger agreement by failing to provide information to it as required under the merger agreement's terms.

For those who can't get ehough of this dispute click here to access Genesco's brief filed prior to the Judge's order, UBS's motion o be granted intervenor status and UBS's answer to Genesco's complaint.

As timely as ever, Nixon Peabody has their Annual MAC Survey out (you can download it here). They state:

We completed this year’s survey before the onset of the credit crisis that began in July 2007. As such, we have not reviewed agreements since that date to determine the impact the crisis will have on deal terms in general and MAC clauses in particular. However, we do believe that the credit crisis will have a chilling effect on the larger transactions and would expect that the overheated pro-seller market will cool off significantly as a result of less leverage being available to private equity buyers. Accordingly, we would expect deal terms (including the MAC provision) to become more buyer-friendly. The extent and swiftness of the change is difficult to predict and may take some time to work its way into the agreements themselves.

I'm not sure I agree with that completely. While buyers may indeed bargain harder because there are fewer deals, you will also see seller attorneys negotiating harder over MAC clauses and reverse termination fees in response to the recent problems in the market. In particular, sellers are likely to insist on more and tighter exclusions to the MAC definition and less likely to accept reverse termination fees in private equity deals (though 3Com is not a good omen for this). There is also the liklihood of a significant rework of these clauses in response to a court decision in either SLM, Genesco/Finish Line or any of the other MAC cases brewing.

It is being reported that Och-Ziff, the hedge fund adviser, set a price range of $30 to $33 a share for its proposed initial public offering of 36 million shares. When it occurs, this will be the third hedge fund or private equity fund adviser ipo after Blackstone and Fortress and marks a return of these ipos post-August market crisis. KKR is the next one on-deck, but expect more of them. I outline the reasons why in my recent paper Black Market Capital:

In my paper, I note that retail investors cannot invest in hedge funds or private equity funds but they can invest in the funds' managers. I argue that the trend of hedge fund and private equity fund adviser initial public offerings is in part due to the SEC rules which prohibit public investment in these funds. Prevented from buying the funds directly, public investors look for something replicating their benefits. The investment banks and other financial actors act quickly meet this demand, but with less suitable and riskier investment vehicles such as fund adviser IPOs, special purpose acquisition companies, business development companies, structured trust acquisition companies, and specialized exchange traded funds all of which largely attempt to mimic private equity or hedge fund returns and have been marketed to public investors on this basis. I term these investments “black market” capital since they are a product of the ban on direct hedge fund and private equity public investing. I argue that these investment tend to be more risky on an individual basis than the hedge fund and private equity funds they substitute for. So, public investors who buy them bear more risk and together inject more risk into the US capital markets than if they were allowed to invest in the funds. These are a perverse consequence of the SEC’s current prohibition. I argue that the SEC should resolve these issues by amending the securities laws to permit public investors to invest directly in private equity and hedge funds. This would recognize the costs in the current regime, end black market capital and allow investors to access the benefits of hedge funds and private equity: excess returns and diversification.

The earnings release is accessible here. A few initial very preliminary observations:

SLM's core earnings fell 19% to $259 million, or 59 cents a share, from $321 million, or 73 cents a share, a year earlier, missing average analysts forecasts by about three cents a share. This includes an 11 cents a share in charges from recent legislative changes and the buyout ($28 million and $18 million, respectively). On this basis, I calculate that the earnings drop attributable to the new Bill is thus far about a nine percent drop in earnings for the 3rd quarter. That is a big drop but according to SLM the hit this quarter is non-recurring and therefore would likely not be considered a MAC by Delaware in the earnings context. So, we will need another quarter to begin to see the full effects of the Bill on SLM's earnings and whether it does indeed arise to the level of a MAC. Unfortunately, SLM does not make any statements about this in their press release. I haven't listened to the conference call yet, but I assume many analysts will be asking this (and I assume they will defer any answer due to the pending litigation).

With the exception of growing assets, SLM missed guidance on EPS growth, loan spread and other income growth. Note that SLM withdrew this guidance on April 24, 2007 after a deal was reached with the Flowers group. I don't have enough information on this to speculate as to whether this further sustains a MAC claim but it no doubt is a driver in the Flowers group's current hesitancy to complete this deal at $60 a share. While the MAC definition does not exclude out failure to meet projections in IBP v. Tyson the Delaware court's refused to find a short term failure a MAC; rather any change to earnings must be long term and materially significant. It remains to be seen whether these failures meet that test.

SLM makes no mention of the dispute with Flowers or otherwise any statements on the current litigation. They also make no forecasts about future earnings or as I said before, the effect of the Bill on the entirety of their operations and core earnings generally.

So, on initial glance not a great quarter for SLM, but I'm still not sure how this plays into the MAC interpretation other than as a driver for the Flowers group to use SLM's deteriorated position to renegotiate a price. I'll have more tomorrow once I listen to the earnings call.

Final Note: My sources say no food at the SLM in-person meeting today. Only soda and tap water.

SLM Corporation is to release third quarter earnings today, before noon. For those wanting some free coffee and perhaps even food there will be a live presentation at noon EDT at the New York Palace Hotel in New York City and will conclude by 1 p.m. EDT.

I'll have some commentary on it later today or first thing tomorrow. Expect SLM to be spinning the earnings to show how great their business is and (relatively) unaffected by the recent market turbulence. It would also be nice if they quantified the full extent the new Bill will have on their revenue and earnings -- but given the litigation, I'm not sure they will or should.

When I posted on Bioenvision last week, the Bioenvision board had adjourned its shareholder meeting to approve a merger with Genzyme by one day; a meeting which had just been held. Bioenvision did so because only 47% of the Bioenvision shareholders had voted in favor of the transaction. I remarked at the time that:

The additional day adjournment was a pure Board maneuver to buy time for stockholders to vote in favor or change their votes in favor of the deal. . . . . The next day the Bioenvision stockholder meeting was again adjourned a second time to Oct 10 at the Friday meeting for the proxy tabulator to calculate the exact shareholder vote. I'm a bit puzzled by this maneuver and find it suspect, even bizarre, given the situation. But time will tell.

Things got a bit odder from there. On Tuesday, Bioenvision filed a petition under DGCL 231(c) with the Delaware Chancery Court to reopen the shareholder voting. Bioenvision claimed this was necessary because:

[M]ultiple errors resulted in the potential disenfranchisement of Bioenvision shareholders. First, the parties received a report that mistakenly stated that Bioenvision was approximately 935,635 votes short of the majority. Second, the parties fully expected SG to vote 1.3 million shares in favor of the Merger and were unaware at the time SG submitted its ballot that it was able to only vote 916,000 shares in favor of the Merger – again, far fewer than expected. Third, the proxy from the JPMorgan Client voting in favor of the Merger was intended to be submitted prior to the closing of the polls. In fact, the JPMorgan Client communicated to Bioenvision that it would be voting its entire position in favor of the Merger and instructed JPMorgan to do so. As already noted, at 11:15 am on October 5, JPMorgan called Broadridge with this voting instruction, which Broadridge asked JPMorgan to confirm in writing via facsimile. At some point between 11:15 am and 11:30 am, JPMorgan faxed written confirmation to Broadridge. AST did not receive a transmission of the JPMorgan Client’s vote from Broadridge until 12:12 pm. Fourth, having mistakenly believed that the vote was secured, based on inaccurate information, the polls were prematurely closed.

The result of these errors was that instead of passing by 55% of the shareholder vote, Bioenvision came up short by 0.43%. I'm pretty sure most of you never learned of DGCL 231(c) in corporations class. It states:

No ballot, proxies or votes nor any revocations thereof or changes thereto, shall be accepted by the inspectors after the closing of the polls unless the Court of Chancery upon application by a stockholder shall determine otherwise.

One day after the petition was filed Chancellor Chandler issued an order without opinion granting Bioenvision's request. Under the Chancery Court's order, Bioenvision will reconvene the special meeting of stockholders on October 22, 2007 for all Bioenvision stockholders as of the record date of September 5, 2007 to again vote on the transaction.

I'm not sure what to make of all this. I think the decision of the Chancery Court was the right one, but given Bioenvision's previous postponements, the prior tender offer by Genzyme which only yielded 15.3% of the common stock, and the opposition to the deal by a number of shareholders and proxy services, I am still a little unsettled by it. Nonetheless, if the merger would actually have been approved I do still think it is the right decision.

The New York Times yesterday had a story on the Acxiom deal termination (I'm quoted in it using the articulate word "really"). According to the Times:

WHEN Acxiom, the information services company, announced last week that its proposed buyers had backed out of their $2.25 billion deal to take it private, the company said that the two firms — ValueAct Capital Partners and Silver Lake Partners — had paid it $65 million, or half of the original $130 million breakup fee. But one important fact was left unsaid: Half of that $65 million fee would be paid by Morgan Stanley and UBS, two of the investment banks that had agreed to finance the deal and stood to lose tens of millions of dollars if the deal were completed because they would have to sell the debt at a discount from what they paid for it, according to people involved in the negotiations.

[NB. The $130 million "break-up" fee above is actually $111.25 million and is what Acxiom would term a damages cap -- see my other post Acxiom Coda Part II)]

The Times then proceeds to note a very interesting fact: Bank of America, a third bank which had agreed to finance the transaction, refused to share their part of the fee and is now in a dispute with ValueAct and Silver Lake who "have threatened to sever their longtime ties with Bank of America." Apparently, Bank of America's justification for not paying the claim is legal exposure to a claim for "tortious interference with contract".

BofA surely knows that the mere invocation of possible liability for this tort is likely to send shivers down an M&A lawyers spine. In the seminal case of Pennzoil v. Texaco, Pennzoil had an alleged informal, binding contract with the Getty Oil company to purchase the company. Texaco intervened with its own proposal and in a San Antonio, Texas court Pennzoil won a $10.53 billion judgement from Texaco on a tortious interference claim. Texaco was forced to declare bankruptcy and eventually payed a lower negotiated amount of $3 billion.

So, clearly BofA is invoking demons here. The question is if they have purchase. A likely case for tortious interference would be sited in Arkansas, headquarters of Acxiom. There, the elements of a claim for tortious interference of contract are:

(1) the existence of a valid contractual relationship or business expectancy; (2) knowledge of the relationship or expectancy on the part of the interferor; (3) intentional and improper interference inducing or causing a breach or termination of the relationship or expectancy; and (4) resulting damage to the party whose relationship or expectancy has been disrupted.

Mason v. Funderburk, 247 Ark. 521, 446 S.W.2d 543 (1969). In determining whether the conduct is improper, Arkansas has identified seven factors to be evaluated: (1) the nature of the conduct, (2) the proximity of remoteness of the conduct to the interference, (3) the motive of the alleged tortfeasor, (4) the relations between the parties, (5) the interests advanced by the tortfeasor, (6) the interests of the victim to be protected, and (7) societal interests in balancing freedom of action by one party with the contractual interests of the other party. Mason v. Wal-Mart Stores, Inc. 333 Ark. 3, 969 S.W.2d 160 (1998).

As an initial matter, the party who would bring this claim would have to be Acxiom or the buyers. But they have all signed a settlement agreement which presumably releases all of the parties from liability on any grounds arising from the terminated merger. So, the question is who could bring this claim? Hypothetically, an Acxiom shareholder might, but I do not think they would get very far particularly since the merger agreement has a no third party beneficiary clause. Even if there was a plaintiff, BofA could claim it was merely exercising it contractual rights under its financing commitment letters. Courts have repeatedly found that a valid exercise of contract rights is not an "improper" action to sustain a tortious interference claim. Ultimately, there is always uncertainty in litigation, but Bof A does not appear to have a good position here. The inherent uncertainty of American litigation, though, is clearly a benefit to them to the tune of about ten million dollars -- or at least enough to sustain a position that they do not need to pay it. Here, the victim is Silver Lake, ValueAct and the other two banks; whether BofA would take the same position with KKR or Blackstone -- two much bigger clients -- is for another day, though, I have my bets.

Likely in response to yesterday's New York Times story Acxiom issued the following press release:

LITTLE ROCK, Ark. – October 10, 2007 - Today, Acxiom® (NASDAQ: ACXM; www.Acxiom.com) reported that it had received full payment of the $65 million settlement amount related to its recently terminated Merger Agreement with Axio Holdings LLC and Axio Acquisition Corp. (collectively “Axio”).

The Company also reported that the $65 million settlement is significantly greater than the one-time expenses related to the terminated agreement and that the Merger Agreement did not include a $111 million termination fee as further explained below.

The Merger Agreement provided that, in the event all conditions to the closing of the merger transaction contemplated by the Merger Agreement were satisfied but the required debt financing for the transaction was not available, the Company would have been entitled to a break up fee of $66.75 million. In other circumstances in which Axio failed to close the proposed transaction in breach of the Merger Agreement, the Company was entitled to seek damages up to a limit of $111.25 million, but was not entitled to compel Axio to close the proposed transaction by seeking to specifically enforce the Merger Agreement.

In the event that a settlement agreement had not been reached, the Company would have had to pursue litigation in order to receive any compensation for damages.

Acxiom's argument is a semantic one. Essentially, under Section 8.1(f) of the merger agreement, the agreement could be terminated:

by the Company, in the event that Newco and Merger Sub are in breach of their obligation to cause the Merger to be consummated pursuant to Section 2.2 because of their failure to receive the proceeds contemplated by the Debt Financing or their refusal to accept Alternative Financing on terms that are not less favorable, in the aggregate, to Newco and the Surviving Corporation than the Debt Financing contemplated by the Debt Commitment Letter . . . .

In cases where the merger agreement was terminated under this clause, Section 8.3(c) required that:

In the event that this Agreement is terminated by the Company pursuant to Section 8.1(f), Newco shall pay to the Company the Newco Termination Fee [$66.75 million], by wire transfer of immediately available funds to an account or accounts designated in writing by the Company, within two (2) Business Days after such termination.

This is the reverse termination fee referred to by Acxiom above. In contrast, the $111.25 million figure is in Section 9.8:

9.8 Newco Damage Limitation. The Company agrees that, to the extent it has incurred losses or damages in connection with this Agreement, (i) the maximum aggregate liability of Newco and Merger Sub for such losses or damages shall be limited to $111,250,000 inclusive of the Newco Termination Fee (and the amounts available under Section 8.3(e)), if applicable. . . .

And Section 8.3(f) further limits the buyers damages if the agreement is terminated under Section 8.3(c) [lack of financing above] to the lower amount of $66.75 million. But generally all other buyer breaches of the agreement are subject to the limitation of $111 million. This gives the buyers the ability to absolutely walk from the agreement if financing is available by paying this $111 million. This is what Acxiom is calling a damages limitation but the Times and others term a reverse termination fee. And it really is semantics. The Times and others do so because effectively this provides a right for the buyer to walk for any reason by paying the $111 million, a number that is reduced to $66.75 million if they are walking due to the negotiated provision of no financing being available. Acxiom calls it a cap on damages because they affirmatively have to sue and prove damages up to the cap. And can you can see the incentives here for the buyer? They will always claim that such financing has become unavailable -- a fact the banks will work with them on to ensure that only the lower fee is payable (I criticized this arrangement previously in the 3Com deal).

In the end, I am not sure why Acxiom is so defensive. Given the deterioration of their business they appear to have done quite well to get the $65 million particularly given the above incentives which drive the maximum buyer fee to the lower cap. Acxiom's agreement to do so was a seemingly rational assessment of the likelihood of success in litigation and the risk involved. Of course, I'd love to know why it was $1.75 million short of the full fee payable in the case of a failure of financing.

For those following the Genesco case, here is their latest filing yesterday in Tennessee Chancery Court. Genesco's filing mainly addresses UBS's attempts to invoke the forum selection clause in their financing commitment letter to avoid being impleaded into the Tennessee litigation, and Finish Line's attempts to delay the Tennessee dispute to resolve this matter. As Genesco states:

Genesco has no objection to UBS and Finish Line agreeing to resolve their dispute in this Court, so long as their doing so does not further delay Genesco's claims against Finish Line. This Court should not, however, permit Finish Line - which, expressly agreed to fight its battles in different forums - to deny through delay the relief to which Genesco is entitled under the Merger Agreement because Finish Line no longer wants to recognize the forum selection clause in the Commitment Letter. If UBS will not agree to submit its dispute with Finish Line to this Court, then Finish Line must bring suit against UBS in New York as it agreed to do in the Commitment Letter.

Either way, these proceedings should proceed without further delay. However much Finish Line might prefer that it were otherwise, there is no legitimate basis for Genesco's claim against Finish Line to be hostage to Finish Line's claim against UBS. Finish Line's contrary arguments - that Finish Line's obligations under the Merger Agreement are contingent on UBS performing under the Commitment Letter and that, therefore, UBS is a "necessary party," are without merit. UBS is not a ''necessary party" to this lawsuit because Finish Line is required to timely close the merger irrespective of whether the UBS (or any alternative); financing is in place. As set forth in the Complaint, the Merger Agreement does not contain a financing condition. To the contrary, the Merger Agreement contains an explicit agreement by the parties that there is no financing condition:

For avoidance of doubt, it shall not be a condition to Closing for Parent [Finish Line] or Merger Sub to obtain the [UBS] Financing or any alternative financing.

Once again Genesco has put things in just the right words. I kind of/sort of feel bad for Finish Line at this point (for more on their position see my post yesterday here). In the filing, I also noted for the first time that Genesco has hired superstar lawyer David Schiller at Boies, Schiller & Flexner in addition to Bass, Berry & Sims. Talk about piling on.

See the press release below. I was meaning to write this up in full tomorrow, but the whole affair is just plain odd. And I wonder what Bioenvision went to court on when it already had the necessary number of votes to effect the merger (my guess -- the winning votes came in only after the meeting had ended). I'll take a look at the petition and other documents and have more later. (Addendum: Here is the petition and here is the order -- it appears that Bioenvision was petitioning to reopen the meeting in order to count late votes -- otherwise the merger would have failed)

NEW YORK and CAMBRIDGE, Mass., Oct. 10 /PRNewswire-FirstCall/ -- Bioenvision, Inc. (Nasdaq: BIVN) and Genzyme Corporation (Nasdaq: GENZ) announced today that the Court of Chancery of the State of Delaware granted a petition filed yesterday by both companies to reconvene Bioenvision's special stockholder meeting on October 22 to vote on the merger agreement between Bioenvision and Genzyme.

Under the Chancery Court's order, Bioenvision will reconvene the special meeting of stockholders on October 22, 2007 and reopen the polls to ensure that all Bioenvision stockholders as of the record date of September 5, 2007 are afforded an opportunity to vote for or against the adoption of the Merger

Agreement and for those votes to be properly counted. Bioenvision will accept for consideration all votes, proxies or ballots related to the merger agreement delivered by any record holder. Bioenvision stockholders are not obligated to take any action or they could change their votes if they chose or vote even if they have not previously cast a vote on this matter.

Appraisal rights are available to all Bioenvision stockholders prior to the taking of the vote on October 22. Bioenvision will provide additional information concerning the reconvened special meeting to all stockholders on the Record Date in a mailing to be sent October 11, 2007.

Based on a preliminary count of the votes received through October 5, 2007, approximately 55 percent of issued and outstanding shares have voted in favor of the merger.

Who needs Stoneridge when you have SLM? Following up on my post yesterday, a few more thoughts:

I noted yesterday that SLM was not retaining its deal counsel, Davis Polk, for the Delaware litigation and thought it interesting for a reason I couldn't peg. But, the reason for this is likely nothing more than a simple conflict. The defendants in this suit include two of the biggest banks in the world, J.P. Morgan Chase and Bank of America. By simple presence, Davis must be representing one of them or have represented one of them recently. And for those who follow their Wall Street history they will guess it is likely J.P. Morgan. John W. Davis was J.P. Morgan's personal lawyer as well as the lawyer for J.P. Morgan, the bank. This also likely explains why SLM went to a litigation boutique, Susman Godfrey, and not another Wall Street law firm -- they are all likely conflicted or otherwise do not want to be seen as suing such a large potential client.

I spoke to a number of reporters yesterday, and the article coming out of TheStreet.com was perhaps the funniest. I quote his article:

J.C. Flowers officials declined to comment, as did representatives of Sallie Mae. An official following the private equity group's position cited a blog written by Wayne State University's Assistant Professor of Law Steven Davidoff.

Now if only I could get Flowers to pay me a scintilla of what they are paying Wachtell et al. for the same analysis. But in all seriousness, I call these disputes as I see them based on the public information available to me. And an important caveat there: I do think Flowers has a good case a MAC occurred but I am not privy to the non-public information. This could establish a much better case for SLM than it currently appears to be. Or, heaven forbid, I could be wrong on the legal analysis.

This leads me to my final thought. I was on the phone with another reporter yesterday who said that he had to believe SLM's argument that only if the difference between the proposals and the enacted Bill is a material adverse effect itself is it not excluded from the definition of MAC. This is despite the plain language of the merger agreement which has no such materiality requirement and only requires that the difference be adverse (see my post explaining this difference here). Anyway, his reason -- SLM could never agree to such a risky proposition. That, if a proposal $1 more adverse to SLM than the proposals in the 10-K were enacted, the buyers could walk based on a MAC. He posited that, faced with this decision, SLM would have chosen the other competing bid which was a $1.50 lower but provided more certainty (this was pure speculation on his part).

My answer: First, the $900 million reverse termination fee already provided a significant walk right to the buyers by capping their maximum liability in such cases. You have to take all of these provisions into account when assessing each one of them. Second, this was a highly negotiated provision and if the buyers, SLM and their very highly paid lawyers wanted to say this, they could have (see, e.g., the MAC in the Fremont General Corporation Investment Agreement negotiated by Skadden and Gibson Dunn and my comment on it here/ This MAC did include a materiality provision in its Applicable Law exclusion). Third, we don't have all of the public information, but if we are to believe the Flowers group the parties very specifically negotiated this as the maximum limit of losses the Flowers group would take. This position is disputed by SLM, but appears supported by the Flowers group's assertion that it would not take the risk on the 10-Q disclosure of the second Kennedy proposal (which is not included in the 10-K). Finally, and more scarily, legal negotiations are often on separate tracks than the financial. The business people may have been focused on the top-line bid number and picked that deal leaving the lawyers to ex post facto negotiate the legal terms for a chosen deal. Once a bidder is picked the push-to-close sets in and heuristic biases push lawyers to accept changes that in the cold light of day they may regret. Claire Hill at Minnesota has written extensively on related but relevant issues of contract negotiation -- you can access her articles here.

We regret that our offer to amend the terms of the Sallie Mae transaction was allowed to expire without discussion. Instead, Sallie Mae filed what we firmly believe is a meritless lawsuit. We now look forward to having this matter resolved in the Delaware Chancery Court."

Today, the discovery hearing in Genesco's suit against Finish Line will reconvene in Tennessee Chancery Court. On Monday it was delayed because UBS has yet to agree to try the case in Nashville. At the time, Finish Line requested a two-day delay in order to attempt to obtain UBS's permission to waive the provisions of UBS's financing letter which set New York as the forum and governing law for any litigation between it and Finish Line. Conversely, the merger agreement between Finish Line and Genesco has a choice of forum of Tennessee and selects Tennessee law to govern the merger agreement. In a post a number of weeks ago I criticized Finish Line's lawyers for agreeing to such provisions:

The MAC clause in the financing commitment letter for Finish Line issued by UBS is identical to the one in the merger agreement with one critical exception. The commitment letter is governed by New York law and chooses New York as its forum for any dispute, the Genesco/Finish Line merger agreement is governed by Tennessee law and selects Tennessee Law. Their choice has now raised the prospect of a court in New York finding a MAC while a court in Tennessee finds the opposite. Now that would be fun (at least from my perspective). This is unlikely from a practical perspective -- who could see courts consciously reaching this result? -- still M&A lawyers in the future would do well to avoid this difficulty.

And I even earlier criticized the lawyers of Genesco and Finish Line for their choice of Tennessee law:

Anyone care to tell me what the law on MACs as applicable to acquisition transactions is in the State of Tennessee? Yeah, that is what I thought you would say -- there is none. Finish Line may be taking a flyer on this uncertainty, although it should be careful as Tennessee is Genesco's home state. This is the second time this week, I have highlighted the importance of choice of law and forum selection clauses in acquisition agreements. Too often they are the product of political negotiations among the parties when they should be negotiating for certainty of law and adjudication. I hate to be a shill for Delaware or New York here, but the alternative result is situations like this.

Finish Line is flailing between UBS and Genesco. The Genesco merger agreement contains no financing out, but If UBS does succeed in ending its financing commitment, Finish Line will likely be unable to secure financing and complete the acquisition sending it into insolvency. Now Finish Line is struggling to keep from fighting lawsuits in two different cities under two different laws to interpret the identical MAC clause. What a mess. Finish Line's lawyers haven't helped it by agreeing to this dichotomous arrangement. I'll say it again: choice of forum and law clauses matter. Remember this M&A lawyers.

Remember Harman Industries? Back on Sept 21 its deal to be acquired by Goldman Sachs Capital Partners and KKR spectacularly collapsed. At the time Harman issued a press release stating:

Harman International Industries, Incorporated (NYSE:HAR - News) announced that it was informed this afternoon that Kohlberg Kravis Roberts & Co. L.P. (KKR) and GS Capital Partners VI Fund, L.P. (GSCP) no longer intend to complete the previously announced acquisition of Harman by a company formed by investment funds affiliated with or sponsored by KKR and GSCP. KKR and GSCP have informed Harman that they believe that a material adverse change in Harman's business has occurred, that Harman has breached the merger agreement and that they are not obligated to complete the merger. Harman disagrees that a material adverse change has occurred or that it has breached the merger agreement.

Since that time Harman has helpfully refused to comment on the status of its merger agreement with GSCP & KKR. The only mention I could find is a reference in a later press release by Dr. Sidney Harman which referred to KKR and GSCP as its "former merger partners".

Am I the only one who finds this bizarre? It has now been about two and a half weeks since that initial announcement and Harman has provided no update on the status of its merger agreement or announced its termination. Technically, the agreement is still in effect and Harman is continuing to operate under it. Well, that doesn't make sense. And, if there has been a repudiation of the merger agreement by the buyers without a material adverse change, the buyers are required to pay Harman $225 million.

If Harman's goal is to move forward from the spectra of GSCP's and KKR's claim of a material adverse change you would have thought they would have dealt with the above issues by now and attempted to collect the $225 million in litigation or otherwise. Instead, Harman is permitting them to linger in uncertainty. Harman is already subject to a number of shareholder class actions over alleged faulty disclosure practices during the time of this transaction. Harman may want to take some lessons from this.

As an initial matter, nowhere in the Complaint does SLM deny a material adverse change has occurred. Rather SLM relies upon the exclusions to the MAC definition (see here for the full MAC definition) to argue that they specifically exclude out the MAC event. This is huge folks -- it significantly narrows the bases for SLM to counter Flower's MAC claim. And on SLM's arguments that it is subsequently excluded, I note the following:

SLM argues that the MAC clause is qualified in its entirety by the disclosure in the Recent Developments in the 2006 10-K and that therefore this specifically contemplated the enacted bill.

My Thought: It's not a bad argument but the Recent Developments section doesn't include the second Kennedy proposal disclosed in their April 10 10-Q. I believe that this is likely the proposal the Flowers group is referring to that it refused to bear the risk on (see below for the 10-Q disclosure). If Flowers can show an exchange to this effect it significantly hurts SLM's position

SLM argues that the "credit crunch" cited by defendants is excluded from the MAE by the prong excluding adverse changes in "general economic business, regulatory, political or market conditions".

My Thought: SLM is likely right here as I noted yesterday. The MAC specifically excludes:

(e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein . . . .

SLM finally argues that the “enacted legislation is entirely excluded from consideration as an MAE unless it is more adverse to Sallie Mae than the” proposals disclosed in the Recent Developments Section of the 10-K. Furthermore, SLM argues that any adverse enacted legislation must be considered in comparison to these proposals. SLM then concludes by asserting that only if the difference between the proposals and the enacted Bill is a material adverse effect with respect to the “totality” of the “financial condition, business, or results of operation” of SLM and its subsidiaries is it not excluded from the definition of MAC.

My Thought: I talked about this point yesterday and noted as follows:

[SLM] is arguing that clause (b) itself contained its own "material adverse effect" qualifier which requires that the disproportionality of the change be itself materially adverse. I'm not sure that I agree here with [SLM]. This language was highly negotiated and clause (b) of the MAE definition only excludes out a MAC to extent it relates to:

changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals . . . .

There is no materiality qualifier here. It only requires that the proposal be adverse in any respect. And SLM has already admitted that it estimates the bill is more adverse to core earnings over a five year period by 1.8%-2.1%. A Delaware court will utilize the normal interpretation rules for contracts when interpreting this provision. This will require it to enforce the plain meaning of the contract unless it is ambiguous. If it is ambiguous the court will then look to the parties' intentions. Here, I doubt a Delaware court would get past the plain reading of this highly-negotiated contract which requires that it only be more adverse.

Moreover, even if [SLM] is correct and Flowers must prove an MAE over and above the "incremental impact of the provisions of the CCRA relative to the pending budget and legislative proposals that are referenced in the 10-K," [SLM] makes another fundamental error. SLM is arguing that the MAE should be measured on a net basis -- the "totality" of the MAE (i.e., they lump together the good and bad effects and take the net effect). However, I believe a MAE is assessed based on the bad effects to the exclusion of the good. After all this is what the parties are assessing. I admit this is an open question under Delaware law, but this is my reading. Moreover, here [SLM] conflates the disproportionate aspect of the proposal with whether a MAE did indeed occur. For these purposes, [SLM does not deny that an MAE occurred in its complaint and] still has not disclosed the numbers necessary to make this calculation. They have only stated that it would have a disproportional impact compared to the disclosure in the 10-K. Thus, the jury is still out about whether an MAE has indeed occurred, though, the way the parties are acting it looks that way -- i.e., if SLM did not have an MAE it would disclose the numbers.

Ultimately, SLM almost wholly relies on this last point to prove that a MAC did not occur. If this is their main argument, I don't think that they have a great case. But litigation is always risky and as QVT noted in their own letter the Delaware courts may decide to award SLM a consolation prize. And as I said last night when commenting on the fact of litigation:

I had predicted that something would happen before the Thursday earnings call, but I am a bit surprised that it went to litigation so fast. That it has come to this I believe reflects the strong position of Flowers et al. that a material adverse change to SLM has occurred. It is a judgment I generally concur with based on the public facts. A reporter earlier tonight informed me that Flowers is responsible for $451.8 million of the termination fee among the three buyers if they are required to pay the $900 million to SLM. This is a huge liability for them -- and their limited partners would not be particularly happy if they are required to pay it. That Flowers and the other buyers would let this risk come to pass not only reflects their position but how far apart SLM and Flowers et al. are in the renegotiations. While this is yet another move in the chess game by SLM, it still appears to be a bit to go before a settlement -- and the settlement increasingly appears to be a lump sum payment on a risk-adjusted basis of the $900 million rather than a completed deal. As usual, I'm rooting for a Delaware opinion to further fill out the Delaware law on what constitutes a MAC . . . .

Final Interesting Point. SLM is using Susman Godfrey as primary litigation counsel. I have never heard of them and they may be an excellent litigation boutique. Still, not using their deal counsel Davis Polk for this litigation is very interesting. This means something but I am not sure what.

Addendum: 5/10/2007 10-Q Disclosure follows (this disclosure is not in the Recent Developments Section of the 10-K referenced in the MAC) [NB. Item 1 highlighted below is never disclosed in the 10-K Section on Recent Developments so arguably doesn't qualify the MAC definition]:

Senator Kennedy Proposal for Title IV Programs It has been widely reported that Senator Kennedy, Chairman of the Health, Education, Labor, and Pensions (“HELP”) Committee has circulated his draft proposals for Title IV programs, including student loan programs and Pell Grants. The proposal, which has reportedly been provided to members of the HELP Committee, proposes to make several reductions in the student loan program: (1) reduce Special Allowance Payments on new loans by 0.60 percentage points; (2) reduce federal insurance on new loans to 85 percent and eliminate Exceptional Performer; (3) increase lender origination fee to 1 percent; (4) reduce guaranty agency collection fee to 16 percent; and (5) base the calculation of the guaranty agency account maintenance fee on number of borrowers rather than loan level. The proposal would also change the delivery of PLUS loans to two different auction models: (1) a loan sale model, where the FDLP would originate the PLUS loans and then auction the loans when they entered repayment; and (2) a loan originations rights auction where the Department of Education would auction off the right to originate loans for each school that participated in the auction. The auction would be based on Special Allowance Payment rates. The proposal would use the savings to pay for (1) a phased in increase in Pell Grants to $5,400 by fiscal 2010; (2) increase eligibility of families for maximum assistance; (3) phase in a reduction in the Stafford interest rate to 5.8 percent over five years; (4) introduce new type of income-contingent repayment plan, which would include FFELP borrowers; and (5) expand loan forgiveness in the FDLP.

The press release is set forth below. I had predicted earlier today that something would happen before the Thursday earnings call, but I am a bit surprised that it went to litigation so fast. That it has come to this I believe reflects the strong position of Flowers et al. that a material adverse change to SLM has occurred. It is a judgment I generally concur with based on the public facts. A reporter earlier tonight informed me that Flowers is responsible for $450 million of the termination fee among the three buyers if they are required to pay the $900 million to SLM. This is a huge liability for them -- and their limited partners would not be particularly happy if they are required to pay it. That Flowers and the other buyers would let this risk come to pass not only reflects their position but how far apart SLM and Flowers et al. are in the renegotiation's. While this is yet another move in the chess game by SLM, it still appears to be a bit to go before a settlement -- and the settlement increasingly appears to be a lump sum payment on a risk-adjusted basis of the $900 million rather than a completed deal. As usual, I'm rooting for a Delaware opinion to further fill out the Delaware law on what constitutes a MAC. I'll have more tomorrow once I obtain a copy of the complaint. Hopefully, it will not be a bare-boned complaint and reveals some more information on SLM's position. Here is the press release.

RESTON, Va., Oct. 8, 2007—SLM Corporation (NYSE: SLM), known as Sallie Mae, announced today that it has filed a lawsuit in Delaware Chancery Court against the buyer group, which includes J.C. Flowers & Co., JPMorgan Chase and Bank of America. The lawsuit seeks, among other things, a declaration that the members of the buyer group have repudiated the merger agreement, that no Material Adverse Effect has occurred under the merger agreement, and that Sallie Mae may terminate the merger agreement and collect damages of $900,000,000. On October 3, 2007, Sallie Mae notified the buyer group that all conditions to closing of the merger had been satisfied, and set November 5, 2007 as the closing date of the merger. In response, the buyer group sent a letter to Sallie Mae on October 8, 2007 asserting that the conditions to closing of the merger have not been satisfied because of, among other things, the alleged occurrence of a Material Adverse Effect under the terms of the merger agreement.

Albert L. Lord, Chairman of Sallie Mae’s Board of Directors, said “We regret bringing this suit. Sallie Mae has honored its obligations under the merger agreement. We ask only that the buyer group do the same. We are prepared to close under the contract the parties signed in April.”

What follows is a copy of what I am told is the letter the Flowers group sent to SLM today which triggered SLM's lawsuit:

Mr. Albert Lord

SLM Corporation12061 Bluemont WayReston, Virginia 20190

Dear Mr. Lord:

We are writing in response to your letter of October 3, 2007, in which Sallie Mae purports to set the closing date of the merger for November 5, 2007.

It would be easier to discuss these matters in person rather than through an exchange of letters. We also would welcome the opportunity to meet with management to discuss our proposal and review the Company’s projections so that we can better understand its views of the values in the Company and the strength of its business plan.

Turning to your letter, we note at the outset that we disagree with your assertion that we have violated any confidentiality obligation. We also disagree with your claim that Sallie Mae is entitled to take the unilateral action of setting a closing date, for at least three reasons. (Capitalized terms used herein that are not defined have the same meaning as provided in the Merger Agreement.)

1. The conditions to closing have not been satisfied because the Company has suffered a Material AdverseEffect.

Under Section 2.01(b) of the Merger Agreement, and as acknowledged by Sallie Mae in its July 18, 2007 Proxy Statement to shareholders, the buying group is not obligated to complete the Merger until the earlier to occur of (i) a date during the Marketing Period specified by the buying group on at least three business days notice to Sallie Mae and (ii) the final day of the Marketing Period, subject in each case to the satisfaction or waiver of all conditions to consummation. As Section 8.09(a) of the Merger Agreement requires the Marketing Period to be kept open for 30 consecutive calendar days, the Closing Date cannot be set until 30 calendar days after the Marketing Period has commenced. Section 8.09(a) of the Merger Agreement makes clear that the Marketing Period will not commence until all other conditions to the consummation of the merger (except for receipt of the officer’s certificate) are satisfied or waived. These other conditions include, without limitation, a condition that the representations and warranties of the Company set forth in the Merger Agreement (including the representation in Section 4.10 entitled “Absence of Certain Changes”) shall be true and correct.

As you know, we believe that if the conditions to the closing of our transaction were required to be measured today, the conditions to our obligation to close would not be satisfied because the Company has suffered a Material Adverse Effect within the meaning of the Merger Agreement. Substantial grounds for our view have been explained to your Board. In light of this, the Marketing Period has not commenced.

2. The Company has not provided us with the Required Information necessary to finance the transaction.

Section 8.09(a) of the Merger Agreement provides — “for the avoidance of doubt” — that “the Marketing Period shall not be considered to have commenced or expired . . . unless during and at the end of the Marketing Period Parent shall have (and its financing sources shall have access to), in all material respects, the Required Information.” The definition of Required Information includes, among other things, “information of the type required by Regulation S-X and Regulation S-K promulgated under the Securities Act and of type and form customarily included in a registration statement on Form S-1.” The definition also includes financial or other information regarding the Company “as otherwise reasonably required in connection with the Debt Financing,” which customarily includes projections based on reasonable assumptions required in connection with the syndication of the bank credit facilities.

After the last due diligence session, we outlined several areas in which we believe that the Company’s projections are questionable. The Company’s representatives indicated that they would present us with updated projections and with further justification and back up for the assumptions underlying those projections. That has not yet happened. The Company also has not provided us with updated pro formas. Since the Company has not provided the buying group with pro formas, MD&A and risk factor disclosure “of the type and form customarily included in a registration statement on Form S-1” and has not provided us with projections of the type required to consummate the Debt Financing, Sallie Mae has failed to provide us with the Required Information necessary for the Marketing Period to commence.

3. FDIC approval of the transfer of the Company Bank has not yet been obtained.

Under the Merger Agreement, approval of the FDIC for the acquisition of the Company Bank is required prior to closing. Section 8.01(a) provides that the buying group shall agree to liquidation or divestiture only if the buying group is unable to obtain regulatory approval in a “reasonably timely manner customary for other transactions of a similar nature . . . .” We do not believe that your assertion that the buying group has been unable to obtain such approval in a “reasonably timely manner customary for transactions of a similar nature” is correct. The processing period for industrial bank applications approved by the FDIC in 2007 ranged from 7 months to 21 months.

We also do not believe that your assertion that our actions have “almost certainly eliminated any likelihood of obtaining such approvals in the near future, if at all” is correct. Our regulatory counsel has been in communication with the FDIC concerning the application, and all indications to us are that the FDIC is continuing to process the application in the ordinary course. Indeed, on October 3, about five hours before you sent us your letter, our counsel called yours to inform him of the latest communication with the FDIC staff.

We do not believe that liquidating the Company Bank makes commercial sense for the Company. Nonetheless, if the Company wishes to pursue this course, without conceding any rights under the Merger Agreement, we are willing to consider this alternative at this time. Please advise us as to the details of how the Company would suggest that this alternative approach to the Company Bank would work.

* * *

In closing, on behalf of our group, let us again state that the issues between our group and the Company would better be dealt with through a meeting than through exchanges of letters. It would be most helpful if management would share its views of the Company’s prospects at that meeting so that we can better understand the value of the Company. We, of course, reserve all rights and waive none.

SLM Corp. releases its third quarter results this Thursday, Oct 11. For those eagerly watching SLM's dance with Flowers et al. and handicapping the possibility of a renegotiation or termination of SLM's deal to be acquired, it will likely provide further information to assess whether a material adverse change has indeed occurred to SLM. In this regard, to the extent there is a settlement of this dispute, there are incentives on both sides to do so before release of this information.

In the interim, I thought I would take a more in-depth look at the SLM argument that no material averse change occurred. Since SLM has been relatively silent on the details, I'm going to rely upon the letter sent by QVT last Friday. QVT makes two essential arguments, 1) no material adverse effect as defined in the the merger agreement occurred, and 2) if one did it is nullified by the MAE qualifers.

As an initial matter, QVT first makes hash of the Flowers group's position that:

The MAE is compounded by the dramatic changes in credit markets, changes that have a disproportionate impact on Sallie Mae, a company that has to raise tens of billions in the wholesale credit markets every year to fund its operations.

As QVT notes:

Indeed, a general financial disruption, such as the recent turbulence in the credit markets, is precisely what the customary language of this exception to the MAE is intended to cover.

Here QVT is referring to the exception in the MAC definition for:

(e) changes affecting the financial services industry generally; that such changes do not disproportionately affect the Company relative to similarly sized financial services companies and that this exception shall not include changes excluded from clause (b) of this definition pursuant to the proviso contained therein . . . .

I think QVT is right. Any change Flowers is asserting is picked up by the exclusion in (e) of the MAC definition.

The next point which QVT makes is that the disporportionality exclusion in (b) of the MAE definition excludes any MAE claim. This excludes from an MAE:

(b) changes in Applicable Law provided that, for purposes of this definition, “changes in Applicable Law” shall not include any changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals described under the heading “Recent Developments” in the Company 10-K, in each case in the form proposed publicly as of the date of the Company 10-K) or interpretations thereof by any Governmental Authority . . . .

QVT uses this provision to argue that:

[W]e doubt very much based on applicable Delaware precedent that a court will interpret the MAE clause actually negotiated to mean that if a change in applicable law is at all more adverse than what is set forth in your 10-K for the year ended December 31, 2006 (the" 1 0- K") then an MAE is deemed to have occurred, regardless of whether such incremental change is itself material. We think a court would instead read the clause as requiring that an event or change have a material adverse effect on Sallie Mae, with materiality judged from the baseline established by what was specifically known to the buyer and carved out in the contract.

QVT is arguing that clause (b) itself contained its own "material adverse effect" qualifier which requires that the disporpotionality of the change be itself materially adverse. I'm not sure that I agree here with QVT. This language was highly negotiated and only requires that:

the changes in Applicable Law relating specifically to the education finance industry that are in the aggregate more adverse to the Company and its Subsidiaries, taken as a whole, than the legislative and budget proposals . . . .

There is no materiality qualifier here. It only requires that the proposal be adverse in any respect. And SLM has already admitted that it estimates the bill is more adverse to core earnings over a five year period by 1.8%-2.1%. A Delaware court will utilize the normal interpretation rules for contracts when interpreting this provision. This will require it to enforce the plain meaning of the contract unless it is ambiguous. If it is ambiguous the court will then look to the parties' intentions. Here, I doubt a Delaware court would get past the plain reading of this highly-negotiated contract which requires that it only be more adverse.

Moreover, even if QVC is correct and Flowers must prove an MAE over and above the "incremental impact of the provisions of the CCRA relative to the pending budget and legislative proposals that are referenced in the 10-K," QVC makes another fundamental error. QVC measures this MAE on a net basis (i.e., they lump together the good and bad effects and take the net effect). However, I believe a MAE is assessed based on the bad effects to the exclusion of the good. After all this is what the parties are assessing. I admit this is an open question under Delaware law, but this is my reading. Moreover, here QVT conflates the disproportionate aspect of the proposal with whether a MAE did indeed occur. For these purposes, SLM has still not disclosed the numbers necessary to make this calculation. They have only stated that it would have a disproportional impact compared to the disclosure in the 10-K. Thus, the jury is still out about whether an MAE has indeed occurred, though, the way the parties are acting it looks that way -- i.e., if SLM did not have an MAE it would disclose the numbers.

And this brings us back to QVT's argument that an MAE cannot not be established under the definition since it was contemplated by:

the legislative and budget proposals described under the heading 'Recent Developments' in the Company 10-K", not just the Bush budget proposals; many of the provisions that Flowers uses to claim that CCRA represents an MAE were already included in such legislative proposals . . . .

Student Aid Reward Act of 2007 On February 13, 2007, Senator Kennedy introduced the Student Aid Reward Act of 2007, which offers financial incentives to schools to participate in the Direct Loan Program. Under the bill, schools would receive payments from the government not to exceed 50 percent of the budget scored “savings” to the government as a result of the school using the FDLP rather than the FFELP. The bill provides that schools could use such payments to supplement the amount awarded to Pell Grant recipients or could use such payment for grants to low- or middle-income graduate students. Schools would be required to join the Direct Loan Program for five years from the date the first payment is made to qualify for the payments. Because payments would be contingent on available funding, schools switching from the FFELP to the FDLP would be paid first and, then, other FDLP schools, if funds remained, would be paid on a pro-rata basis.

President’s 2008 Budget Proposals On February 5, 2007, President Bush transmitted his fiscal 2008 budget proposals to Congress. The budget included several proposals that would reduce or alter payments to both lenders and guarantors in the FFELP. The specific proposals include: (1) reducing special allowance payments on new loans by 0.50 percentage points; (2) reducing the default guaranty from 97 percent to 95 percent; (3) reducing payments to Exceptional Performers by two percentage points; (4) doubling lender origination fee for FFELP Consolidation Loans, from 0.5 percent to 1.0 percent; (5) reducing collections retention to 16 percent beginning in fiscal 2008; (6) reducing administrative cost allowance payments to guaranty agencies, changing the formula from a percent of original principal to a unit cost basis; and (7) eliminating the Perkins loan program. If enacted in their current form, and the Company takes no remedial action, the FFELP programs cuts proposed in the President’s budget proposal detailed above, which are to be implemented prospectively, could over time have a materially adverse affect on our financial condition and results of operations, as new loans originated under the new proposal become a higher percentage of the portfolio.

Student Loan Sunshine Act In February 2007, the “Student Loan Sunshine Act” was introduced in both the House and Senate with the stated purpose of protecting student loan borrowers by providing them with more information and disclosures about private student loans. The bill applies to all lenders that make private educational loans through colleges and universities, as well as to lenders of direct-to-consumer educational loans. The bill’s provisions also apply to post-secondary educational institutions that receive federal funds. The legislation would impose significant new disclosure and reporting requirements on schools and lenders and would prohibit gifts with a value greater than $10 from lenders to financial aid professionals. The legislation would require schools to include at least three unaffiliated lenders on any preferred lender list. The legislation would amend the “Truth in Lending” Act to require lenders to notify the school if their student, or parent of their student, applies for a private education loan, regardless of whether the lender has an education loan arrangement with the school, and to require the school to notify the prospective borrower whether and to what extent the private education loan exceeds the cost of attendance, after consideration of all federal, state and institutional aid that the borrower has or is eligible to receive. If the Student Loan Sunshine Act is enacted in its current form, it could negatively impact the financial aid process and the timely disbursement of private education loans, including the efficiency of direct-to-consumer loans, for borrowers at post-secondary education institutions, all of which could adversely affect our results of operations. In addition, the bill could adversely affect the strategy under which our primary marketing point of contact is the school’s financial aid internal brand originations.

Student Debt Relief Act of 2007 On January 22, 2007, Senator Edward Kennedy (D-MA) introduced the Student Debt Relief Act of 2007 (S. 359) along with Senators Durbin (D-IL), Lieberman (D-CT), Mikulski (D-MD), Obama (D-IL), and Schumer (D-NY) as co-sponsors. The proposed legislation would, in addition to increasing Pell grants and providing other benefits to student loan borrowers, • once again allow in-school loan consolidation and allow “reconsolidation” of FFELP Consolidation Loans; • make charging Direct Loan origination fees subject to the discretion of the Secretary of Education; and, for borrowers with Direct Loans only, provide borrowers employed in public service with loan forgiveness after 120 payments under the income contingent repayment plan. The Student Debt Relief Act also contains the provisions of the Student Aid Reward Act of 2007 (see discussion below). If the Student Debt Relief Act becomes law in its current form, it could negatively impact the Company’s future earnings. College Student Relief Act of 2007 On January 17, 2007, the U.S. House of Representatives passed H.R. 5, the College Student Relief Act of 2007. The bill was principally designed to lower student loan interest rates paid by borrowers of subsidized undergraduate FFELP and FDLP loans over a five year period beginning July 1, 2007, from 6.8 percent to 3.4 percent in 2011. Because the lender rate is separate from the borrower rate, the interest rate cut does not affect lenders. The interest rate cut, however, does have a sizable budget effect because the federal government pays to the lender any positive difference between the lender rate and the borrower rate. To offset the additional budget cost, the legislation makes several changes to increase costs to lenders and guaranty agencies. The legislation would reduce default insurance from 97 percent to 95 percent, eliminate Exceptional Performer, double the lender origination fee on all new loans from 0.5 percent to 1 percent, reduce special allowance formula on all new Stafford, PLUS, and FFELP Consolidation Loans by 0.1 percent (exempting the smallest lenders) and increase the offset fee that consolidation lenders pay, to 1.3 percent for consolidation loan holders whose portfolio contains more than 90 percent FFELP Consolidation Loans. The legislation would reduce the amount that guaranty agencies may retain upon collecting on defaulted claim-paid loans. The legislation will be transmitted in the Senate, where it will be referred to the Senate Health, Education, Labor, and Pensions Committee and is unlikely to be considered as a stand-alone bill. The Senate HELP committee is expected to begin consideration of the Reconciliation of the Higher Education Act prior to its expiration in June and sections of H.R. 5 could be considered as part of that legislation. The Company has several loan pricing mechanisms, such as the level of Borrower Benefits, that would mitigate some of the negative impact of this proposal. Also, reduced profitability in the student loans could result in a number of our competitors leaving the industry which would benefit us. In addition, this legislation would be implemented prospectively, so its effect would gradually impact us over a number of years. Accordingly, we cannot predict the effect of this proposed legislation on the Company’s financial condition and results of operation.

[NB. There is a bit more here but for the purpose of brevity it is omitted]

The Flowers group states in its own letter that:

Near the end of our negotiations, Senator Kennedy made a proposal that called for subsidy cuts deeper than the cuts described in the 10-K. The company asked us to accept the risk that the Kennedy proposal would become law. We refused. We drew the final line -- the maximum pain we were willing to take -- at the Bush Budget Proposal.

Here I believe the Flowers group is incorrect. The Recent Developments section of the 10-K does include a Kennedy proposal and is therefore included in the MAE exclusion (I am not sure if this is the one the Flowers group is referring to, but nonetheless it does include at least one Kennedy proposal). [NB. A reader subsequently wrote to say Flowers may be referring to the Kennedy proposal referred to in SLM's 10-Q filed on May 10, 2007).

Nonetheless, to determine if QVT is right, the question comes down to whether the current Bill as enacted was contemplated in the Recent Developments section. All of the representations and warranties in the heading of Article IV are qualified by the disclosure in the 10-K (excluding the Risk Factors). The MAE that the buyers are claiming is a breach of the representation is in Section 4.10. QVT is thus likely arguing here that the Recent Developments section qualifies this MAE even though it was not specifically contemplated in the MAE definition. This is an interesting argument because I doubt the parties intended it: clearly the MAE definition was meant to be bargained for as an independent being. But still, a court could adopt a literal reading of the agreement and find that this risk factor qualifies the MAE representation. And if it finds it contemplated the new budget proposal was at least partially disclosed in the 10-K it could mean that QVT is right and these elements need to be excluded out of the MAE to determine if an MAE even occurred. Food for thought.

Otherwise, with this exception I still believe that an MAE here likely occurred. And of course, this is only the legal case. The $900 million reverse termination fee changes the negotiating calculus substantially.

Last week Bioenvision engaged in similar maneuvers as OSI Restaurant Group took earlier this Spring in attempting to gain stockholder approval of Bioenvision's troubled deal to be acquired by Genzyme. The Bioenvision board convened the meeting on Oct. 4 and then promptly obtained a shareholder vote to adjourn the meeting to the next day on Friday, Oct 5 (here is the similarity with OSI which did a similar thing). The reason why? Only 47% of the Bioenvision shareholders had voted in favor of the transaction. The additional day adjournment was a pure Board maneuver to buy time for stockholders to vote in favor or change their votes in favor of the deal. Under Delaware law Bioenvision needs an absolute 50% majority to approve the transaction. And as a technical matter, this is different than what Topps did. The Topps Board relied on Strine's recent decision in Mercier, et al. v. Inter-Telto post-pone its shareholder meeting itself in order to (successfully) gain time for stockholders to approve its transaction. This is different than Bioenvision where the stockholders themselves voted to adjourn the meeting. Accordingly, Bioenvision's maneuver was less egregious than Topps's in that the shareholders here acted under Bioenvision's by-laws and this was not an act of the Board. To explain why these companies took these different tacts start with the by-law provision which Bioenvision relied upon:

1.7 Adjournments. Any meeting of stockholders may be adjourned to any other time and to any other place at which a meeting of stockholders may be held under these Amended and Restated Bylaws by the stockholders present or represented at the meeting and entitled to vote, although less than a quorum, or, if no stockholder is present, by any officer entitled to preside at or to act as Secretary of such meeting. It shall not be necessary to notify any stockholder of any adjournment of less than 30 days if the time and place of the adjourned meeting are announced at the meeting at which adjournment is taken, unless after the adjournment a new record date is fixed for the adjourned meeting. At the adjourned meeting, the Corporation may transact any business which might have been transacted at the original meeting.

This is a rather flexible version of this by-law. Compare this with the Topps's by-laws which contain no provision for shareholder adjournment of meetings except in the absence of a quorum. And since the Delaware General Corporation Law contains no default rule as to how to handle adjournments outside the no quorum context, Topps was left with some uncertainty as to how to go this route and in particular the required vote to adjourn the meeting (i.e., absolute majority or majority of quorum, etc.). Topps attempted to address this in their proxy statement by including an item that:

To approve the adjournment of the special meeting for, among other things, the solicitation of additional proxies in the event that there are not sufficient votes at the time of the special meeting to approve and adopt the Merger Agreement and the transactions contemplated thereby, including the merger . . . .

Nonetheless, the uncertainty on the threshold vote required to adjourn may explain why Topps opted for the more problematical option of the Board post-poning this meeting rather than the stockholders. I say problematical because post-Mercier these decisions are still subject to a higher standard of Blasius review under Delaware law for these Board-initiated postponements albeit with wide latitude under the specific holding of the Mercier opinion. In contrast, the Bioenvision postponement was a simple exercise of discretion under the by-laws.

Accordingly, M&A lawyers conducting target takeover reviews would be well advised to revise their client's by-laws to include a provision similar to one in Bioenvision's by-laws to provide their boards with maximum latitude to protect agreed deals and avoid a Mercier problem. I know, this goes against my general pro-stockholder stance but still, this is the way it works.

The Bioenvision stockholder meeting was again adjourned to Oct 10 at the Friday meeting for the proxy tabulator to calculate the exact shareholder vote. I'm a bit puzzled by this maneuver and find it suspect, even bizarre, given the situation. But time will tell.

It is being reported that Lone Star completed its tender offer for Accredited Home Lenders at midnight Friday, Oct 5. Congratulations to those arbitrageurs who bet on Lone Star completing the deal. But for me, the deal was a disappointment because it would have been nice to see another case in Delaware interpreting a material adverse change clause and the disproportionality exclusion in particular. Nonetheless, the deal provides many lessons on the behavior of corporate actors in the exercise and resolution of MAC claims. I'm putting together a case study on it for my M&A class which I will make available when completed. For those still nostalgic, here are links to all of my posts discussing the transaction: